How not to let the cat out of the bag? With earnings conference calls a routine quarterly corporate ritual nowadays, how can top management guard against unintentionally revealing potentially damaging inside information in the course of responding to analyst and investor queries?

An obvious way is through scripting – anticipating questions that may be troublesome and preparing answers that will yield no hint of problems ahead. But now some new research raises red flags for both managers and investors about this practice.

A study in the new issue of the American Accounting Associationjournal The Accounting Review finds ''a negative current market reaction to Q&A scripting, suggesting that investors discern the lack of spontaneity and view it as a negative signal, thus calling into question the usefulness of this strategy as a means of delaying the disclosure of bad news for investors."

Based on a sample of conference calls made by 2,861 firms over the course of 10 years, the paper’s author, Joshua Lee of Florida State University, finds that shares of firms which relied most heavily on scripting (the top quintile in this regard) sustained a two-day market-adjusted return significantly below the sample mean on the day of and day following conference calls. While the mean two-day market-adjusted return for the sample was a gain of 0.1%, heavily scripted firms lost 0.2%, putting them 0.3 percentage points below the average. In marked contrast, shares of firms that employed scripting minimally or not at all rose 0.3 percentage points above the mean.

And these market responses were not misguided, the study reveals. Probing unexpected earnings (the amount that earnings diverge from analyst predictions), Prof. Lee finds that "investors' reaction to managers' lack of spontaneity is consistent with negative future unexpected accounting performance in the next two quarters" -- or, put slightly differently, "is consistent with [weak] future firm fundamentals." Mean unexpected earnings of the quintile of firms that scripted most were 12.5% lower than the unexpected-earnings mean of the full sample over the two quarters, suggesting that they had more bad news to hide at the time of the conference call.

Prof. Lee made these findings by using linguistic software to compare the difference in managerial speaking style between the two portions of conference calls – the management discussion (MD), in which the CEO, CFO or other management spokesperson reads from a prepared text, and the Q&A portion in which he or she responds to questioning from analysts and investors. As the paper explains, "Research suggests that the style of written language differs fundamentally from spontaneous speech...If the manager adheres to a script when responding to analysts' questions, the manager's speaking style during the Q&A is more likely to resemble the style of the MD portion. If, on the other hand, the manager speaks spontaneously, speaking style is likely to significantly differ between the two portions of the call."

Employing an intricate methodology that combines trigonometry and vector math, the professor gauges the degree of difference between the MD and Q&A portions of 40,820 earnings conference calls and how it relates to a variousfirm-specific stock-market and earnings measures. In testing whether his findings are statistically significant, he controls for an array of factors that can affect investors' response to calls, including surprises in current earnings; surprises in future-earnings guidance issued during calls; the tone of calls (balance between positive and negative words); and whether a management spokesperson refuses to respond to a query.

In addition to discovering that scripting is negatively related to firms’ two-day market returns and to longer-term unexpected earnings, Prof. Lee found the following:

■The greater the amount of scripting, the further downward analysts revisetheir earnings forecasts for the firm during the 30 days following a call, evidence that, as the study puts it, they "view managers' lack of spontaneity as a negative signal."

■Greater scripting occasions greater bid-ask spreads on company stock in the three days following a call as compared to spreads in the three days preceding the call, a finding which casts doubt that the purpose of scripting is to reduce investor uncertainty.

■Firms that rely heavily on scripting (top decile in reliance) are about 20% less likely than those that are least scripted (bottom decile) to issue future earnings guidance in the course of the call. This finding, like the previous result, "suggest[s] that firms provide less, not more, information when their managers adhere to a Q&A script."

While the study's findings amount to a red flag for investors who detect scripting in a chief's response to queries, Prof. Lee cautions against jumping too quickly to conclusions. "A CEO or CFO who is not especially fluent," he says, "may simply prefer to have answers laid out in advance, so one can't be sure that some kind of concealment is going on without knowing the chief's normal modus operandi. A better bet is to listen for shifts between spontaneous answers and what sound like scripted ones, shifts suggesting a sensitive issue."

He also concedes that in some circumstances scripting may be the lesser of two evils for managers, its negative effects notwithstanding."Managers may find themselves between a rock and a hard place, where the disadvantages of inadvertently disclosing something unfavorable are greater than sounding scripted. It's a dilemma that more than a few top managers are likely to face at some point."

The new study, entitled “Can Investors Detect Managers’ Lack of Spontaneity? Adherence to Predetermined Scripts during Earnings Conference Calls,” is in the January/February issue of The Accounting Review, published every two months by the American Accounting Association, a worldwide organization devoted to excellence in accounting education, research, and practice. Other journals published by the AAA and its specialty sections include Auditing: A Journal of Practice and Theory, Accounting Horizons, Issues in Accounting Education, Behavioral Research in Accounting, Journal of Management Accounting Research, Journal of Information Systems, and The Journal of the American Taxation Association.